August 26th 2021
Factors to Consider as a Self Employed Mortgage Hunter
By Lucas Samuels
Many self-employed individuals have a harder time getting loans because they don't have a steady income. Because it can be difficult for self-employed people to predict their income, banks are leery of how their credit will be affected. Some banks won't even finance self-employed borrowers who have a variety of sources for their income, such as an online business, rental properties, or contract work.
If you're a self-employed borrower who encounters obstacles in securing financing, it’s advisable to visit your local financial advisor to ask for more options. But for now, consider the following advice on how to get the loan you need to buy your home.
Why it’s more difficult to get a mortgage as a self-employed borrower
The main disadvantages self-employed borrowers face when trying to get a mortgage are:
- You can't always prove income.
- Your credit history may not be relevant to your current financial responsibilities, which means that you might have no or poor scores on the two major credit reporting agencies in Canada (Equifax and TransUnion)
Self-employed borrowers may be viewed as higher risk by lenders. Full-time employees are typically considered lower risk since they make a steady income that’s easily verifiable. A person who is an employee and has excellent credit history is considered the ideal borrower. Those who are self-employed have to provide more paperwork to demonstrate their sources of income.
An additional issue with self-employed mortgagors is that they might use business expenses to reduce taxable income on tax returns, which leads lenders to wonder if the borrower makes enough to afford a property. Lastly, banks might prefer to see a lower loan-to-value (LTV) ratio for self-employed borrowers, meaning the self-employed borrower has to provide a larger down payment.
How to become a candidate lenders want
Borrowers who are certain they can make regular mortgage payments can do the following to increase their chances of obtaining a loan:
Establish a self-employment track record
Self-employed borrowers can get a leg up on traditionally employed borrowers by proving to lenders that they have been successful in their ventures. This could be done by providing copies of several years of tax returns, as well as bank statements for the same period.
Lenders also consider regular income from self-employment in order to approve a mortgage application. Ideally, you should have at least two years of self-employment history. The longer the history, the better.
Self-employed borrowers also need to be prepared to show that their businesses are viable and will continue into the future. This can include providing a business plan, your market research, and five years' worth of invoices for services/goods that you have provided.
Have an excellent credit score
Lenders want to see excellent credit scores of over 700. Poor financial histories will carry a much higher interest rate than a self-employed person with a strong credit history. This is because lenders tend to take more risks when assessing an application from a self-employed borrower, and they compensate for this risk by demanding higher interest rates. A higher credit score will make you a more attractive candidate who qualifies for the lowest mortgage rates.
Provide a larger down payment
A larger down payment will demonstrate that you can support the mortgage payments and other financial obligations. The more equity a borrower has in a home, the less likely they are to walk away from it. A higher down payment might also mean you'll be eligible for better terms like lower interest rates.
Have an emergency fund
A financial emergency can strike without warning, and savings show to a lender that you’re prepared in case your business isn’t doing well. A self-employed borrower should have an emergency fund that could cover six months of necessary expenses in case they lose their job or experience another type of unexpected loss of income.
Pay off debts
The best thing a self-employed borrower can do to improve their chances of approval is to pay off any outstanding debt before applying for a mortgage loan. If your credit cards and car loans are paid off, you may qualify for a better loan.
Self-employed borrowers planning to use income from other sources to assist with the down payment should also consider waiting until those funds arrive before applying.
Provide sufficient documentation
When self-employed borrowers apply for a mortgage loan, they must provide documentation to support the income they've declared.
Self-employed borrowers should keep track of all their income and expenses throughout the year so that they can provide documentation at tax time each year. Providing tax returns, profit and loss statements, and balance sheets will increase the chances of being approved for a loan. Other documents you might be asked to provide include:
- list of debts and monthly payments
- lists of assets
- bank statements
- additional sources of income (Social Security, alimony, etc.)
- Proof of business (business license, accountant statements, etc.)
Being self-employed shouldn't hinder your chances of getting a mortgage. Many lenders are happy to work with self-employed borrowers, but it isn’t the same process as applying for a mortgage if you’re employed by someone else. It's hard to figure out how much home you can afford since your income fluctuates from month to month, and it can be difficult to show lenders that you have enough money for the down payment as well as an emergency fund.
The mortgage application process might be more of a headache because of having to submit additional information and paperwork to ensure that your income is stable, but it’s still possible for you to secure a mortgage.
If you have any questions regarding the process of applying for a self-employed mortgage, establishing your income, or how much home you can afford, feel free to contact an expert to explore your options.